Renewable Investments And Customer Expansion Expected To Strengthen Future Stability

Key Takeaways

• Heavy investment in renewable projects and electrification is expected to boost revenue, stabilize against price volatility, and enhance customer connections.
  
• Focus on energy security, generation efficiency, and customer satisfaction should ensure revenue stability, margin improvements, and robust earnings growth.
  
• Rising operating costs, earnings volatility, and drought-affected hydro generation could challenge Mercury NZ's profitability and future liquidity amid uncertain gas supplies and elevated electricity prices.

Catalysts

Engages in the production, trading, and sale of electricity and related activities in New Zealand.

• Mercury NZ is investing heavily in renewable projects, with NZ$1 billion allocated to three major projects expected to generate over 1 terawatt-hour per annum upon completion. This should boost future revenue and provide long-term stability against power price volatility.
  
• The company's focus on electrifying customer connections, highlighted by a significant deal with Fonterra and increasing its customer base by 33,000 connections in a year, likely enhances future earnings and revenue streams.
  
• Mercury NZ is developing initiatives to address New Zealand's energy security, including a potential strategic increase in the generation portfolio length and a focus on hydrology management. This ensures operational efficiency and revenue stability during periods of fluctuating energy supply.
  
• The completion and upcoming deployment of turbine generation projects and new geothermal wells are expected to enhance generation efficiency and capacity, which should support revenue and potential margin improvements.
  
• The company's strategy on maintaining high dividends and a robust focus on customer satisfaction and retention, coupled with ongoing initiatives to manage operational expenses through delayed synergies, should positively affect net margins and earnings.

Mercury NZ Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Mercury NZ's revenue will decrease by 1.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.4% today to 9.8% in 3 years time.
• Analysts expect earnings to reach NZ$334.6 million (and earnings per share of NZ$0.24) by about March 2028, up from NZ$49.0 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as NZ$270 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 33.4x on those 2028 earnings, down from 157.1x today. This future PE is greater than the current PE for the AU Electric Utilities industry at 30.7x.
• Analysts expect the number of shares outstanding to grow by 0.36% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.61%, as per the Simply Wall St company report.

Mercury NZ Future Earnings Per Share Growth

Risks

• The increase in operating expenses (OpEx), up by 16% to NZ$207 million, driven largely by generation maintenance and brand refresh costs, could put pressure on net margins if not managed effectively.
  
• The reported net loss of NZ$67 million, partly due to negative fair value movements in financial instruments, highlights volatility in earnings.
  
• The ongoing and forecast drought conditions have negatively impacted generation volumes, particularly hydro, reducing revenue generation by almost NZ$45 million, which could persist if dry conditions continue.
  
• The higher provisional tax payments, increasing operating cash flow by 20% to NZ$227 million, constrains cash availability for other strategic initiatives, potentially impacting future liquidity.
  
• Rising costs and uncertain gas supplies could keep electricity prices elevated, which might not be fully passed on to customers, affecting overall profitability if this leads to reduced electricity demand or loss of market share.

Valuation

• The analysts have a consensus price target of NZ$6.518 for Mercury NZ based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NZ$7.39, and the most bearish reporting a price target of just NZ$5.7.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be NZ$3.4 billion, earnings will come to NZ$334.6 million, and it would be trading on a PE ratio of 33.4x, assuming you use a discount rate of 6.6%.
• Given the current share price of NZ$5.5, the analyst price target of NZ$6.52 is 15.6% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.